1. SHADOW ECONOMIC ACTIVITIES IN ITALY, SPAIN & SWITZERLAND: A REVIEW OF THE LITERATURE V. Vlachos, A. Bitzenis, P. Kontakos University of Macedonia, Thessaloniki, Greece Sunday, March 1, 13:00-16:00, Q 102 (Building Q), Al-Ain Univ. of Science and Technology Session [4]: Regulation, Auditing & Consumption Patterns 26 th B&ESI Conference 2015 Al-Ain, UAE, March 1-4, 2015

2. 2 Note: The current paper is presented under the auspices of the THALES Research Programme. THALES Programme has been co- financed by the European Union (European Social Fund - ESF) and Greek national funds through the Operational Program “Education and Lifelong Learning” of the National Strategic Reference Framework (NSRF).

3. Foreword to our Project Our aim is to research and measure the various aspects of shadow economy in Greece, including corruption, tax avoidance, social contribution avoidance, undeclared or illegal work, shelf consumption, illegal acts (black or underground economy). It will cover all economic agents in Greece, such as citizens and corporations (e.g. public and private individuals, companies and all professional categories, etc.) The research is also performed at sector levels, e.g. to identify the extent of tax evasion and corruption in the trading of oil in Greece. 3

4. Foreword to our Project (cont.) It does not aim to the precise percentage regarding the measurement of Greek shadow economy but aims to the qualitative analysis of questionnaire results and the comprehension of the problem. The implementation of our interviews, scientific games and economic experiments (tax compliance games) will involve at least 2,000 individuals and business owners (in majority small businesses). The project aspires to achieve numerous objectives, among which the development of a relevant theoretical background, and perform cross-country comparisons at regional level, but also with country groups with advanced taxation systems. 4

5. Agenda 1. Aim of the paper 2. Introduction 3. Stylized facts and scope of the study 4. Switzerland 5. Italy 6. Spain 7. Conclusions 5

6. 1. Aim of the paper To identify which factors have an impact on tax morale and tax compliance in a selected sample of developed countries. Empirical evidence retrieved from other contemporary studies is utilized for this purpose, based on an extended literature review performed by the authors. The methodology used is that of descriptive analysis. Comparative profiles for each of the three countries are developed, with reference to various aspects of shadow economy, including corruption, tax avoidance, social contribution avoidance, undeclared or illegal work, shelf consumption, illegal acts (black or underground economy). Our ultimate aim is to use the three countries as benchmarks and input for future work in the case of Greece. 6

7. 2. Introduction The report is structured as follows: The next section provides a synopsis of some stylized facts pertaining to the shadow economy, i.e. its synthesis and determinants, the methods to measure it, its impact on the official economy and its relation with corruption. The same section also provides information about the studies reviewed. Sections 4 to 6 refer to the countries of interest. Finally, section 7 summarizes the findings of the studies reviewed. 7

8. 3. Stylized facts and scope of the study A wide range of methods has been developed to evaluate and understand the dimensions and causes of shadow economy and corruption in the past three decades. These can be generally grouped under two approaches: indirect (macroeconomic) and direct (microeconomic) methods of measurement. Indirect methods are mainly intended at measuring the size of shadow economy. The real meaning of these methods is that they construe observable phenomena as signs of the unseen part of the economy. The most famous are discrepancy methods based on data comparisons, e.g. between labour force surveys and business statistics, as well as monetary methods (see e.g. Schneider and Enste, 2000). 8

9. 3. Stylized facts and scope of the study (cont.) Direct methods refer to survey-based methods. They can measure not only the size but also the structure & motivations of the participants involved e.g. in undeclared work. Such methods have been applied in a number of countries in recent years. The commonly found macro estimations of the shadow economy is based on cross-country panel estimates of the multiple indicators multiple causes (MIMIC) approach that succeeded the currency demand approach (see the work of Schneider). The commonly explored determinants of the MIMIC approach are the tax burden (+), the self-employment quota (+), the unemployment rate (+), regulations (+), the quality of formal institutions measured (-) and the level of tax morale (-). With regard to the countries of interest to this report, the average estimates for the period 1999-2007 are 27% of GDP for Italy, 22.5% for Spain & 8.5% for Switzerland (Schneider et al., 2010). 9

10. 3. Stylized facts and scope of the study (cont.) The terms included in this report are shadow /informal /underground economy, which have the same meaning. The total hidden or total unobserved economy includes criminal activities. The formal /official economy are terms with the same meaning. Informal employment /labour and undeclared work have the same meaning and constitute part of the shadow economy. The shadow economy is more than tax evasion as it is the sum of all forms of tax non-compliance which are irrelevant to tax evasion, such as tax avoidance and concerns other activities generating concealed income such as bribery. Another issue discussed is the relation/effect of the shadow economy on the formal economy. The shadow economy may be pro-cyclical (i.e. follow) or counter-cyclical to the business/economic cycle. Schneider (2005) finds a negative correlation for developing countries & a positive for developed & transition countries. 10

11. 4. Switzerland There are but a few studies that focus exclusively on Switzerland that discuss the size and the determinants of its shadow economy. Nevertheless, the country is always included in MIMIC approaches. Although the last exclusive study of the Swiss shadow economy in the previous century is three decades old (e.g., in 1985, the estimated size of the Swiss shadow economy was ∼ 4% to 5% of GNP), the interest re-emerged after the year 2000. The contemporary literature focuses on tax morale. This is because it was perceived by the mid-1990s that tax morale can help explaining the high degree of tax compliance in the country. In addition, beyond the importance of tax morale, the literature gives attention to the effect of political institutions on tax compliance. 11

12. 4. Switzerland (cont.) Torgler et al. explore the relationship between local autonomy, tax morale and the size of the shadow economy. The authors provide evidence using Swiss data at the micro and meso level (through Swiss cantons) that local autonomy is highly relevant to understand why individuals cooperate with societies rules. Local autonomy allows the expression of local preferences, thus increasing the willingness to pay taxes. Based on data of the Swiss Cantons, Schneider et al. estimate through the MIMIC method that the shadow economy peaked in 2003 at ∼ 9% of GDP and since then it follows a downward trend. Torgler & Schneider also explore the determinants of the shadow economy via cantonal data. Per the authors it is determined by religion (+), house ownership (+), probability of detection (+), urbanization (+), labour force (-), democratic participation rights (-), tax morale (-) and the tax burden (-). 12

13. 5. Italy The National Institute of Statistics (ISTAT) generates estimates for the Italian unobserved economy, which is comprised by the shadow and the illegal economy. Respectively, Ardizzi et al. and based on data for 91 Italian provinces for the years 2005-2008, find that the average shadow economy was 16.5 percent of GDP (the lowest being 14.5 percent and the highest being 18.5 percent). Ardizzi et al. argue that their lower estimates of the Italian shadow economy is due to their decision to distinguish between the shadow and the illegal economy as parts of the whole unobserved economy (something ignored by the international literature) and thus, generate different estimates. 13

14. 5. Italy (cont.) Turning to the determinants of the shadow economy, Chiarini et al. by testing the cross-elasticity between tax evasion and average fiscal pressure, report that in equilibrium, an increase of 1 percentage point in the apparent tax rate brings the share of unreported tax liabilities up by 0.49 percentage points. In an experiment (with 505 students) for the exploration of tax compliance, Lewis et al. observe that Italian students declare less than UK students and as such, report that culture is an important factor in tax avoidance. Based on data from the Bank of Italy's Survey on Household Income and Wealth, Cannari & D’Alessio study the Italian households’ perception about tax evasion. They find that the propensity towards tax evasion increases for the self-employed, blue-collar workers, urban centres with higher crime rates and unemployment; and, decreases with education and age. 14

15. 5. Italy (cont.) Venturini & Villosio account for immigrants and assert that the general pattern for foreign workers appears to be a fragmented career, either restricted to seasonal or temporary employment or alternating between formal and informal employment. Reyneri supports the argument that the Italian shadow economy has been well established for a considerable period and as such, the author sees the migrants’ contribution only towards its continuation. Based on fieldwork in the metropolitan area of Milan, Reyneri shows that measures aimed at making migrant workers emerge from their irregular status and the shadow economy had only partial and temporary success because of the large domestic shadow economy, which attracts those migrants who are prone to accept irregular stay and informal working conditions. 15

16. 5. Italy (cont.) With regard to the effects of the shadow economy on the formal economy, Busato et al. indicate through a dynamic general equilibrium model that the shadow economy mitigates the distortionary impact of fiscal policies (i.e. has a counter-cyclical effect). Baculo explores the complexity of informal employment in Southern Italy. He argues that is not a structural problem, since it does not concern equally all sectors, being particularly high in the agricultural and service areas and notably high in construction. Finally, with regard to the phenomenon of corruption, compared to other developed economies, Italy is strongly affected by it. For example, according to the Corruption Perceptions Index results for 2013, Italy is placed on the 69th position and is falling behind from all euro-zone member states but Greece. 16

17. 6. Spain The estimation of the Spanish shadow economy has always been of interest to scholars. There have been both many papers in terms of quantity and quality in every decade since the phenomenon gained interest. Alanon & Gomez-Antonio employ the MIMIC approach to estimate the size of the shadow economy. They report ranges between 8 and 18.8 percent of GDP during the period 1976-2002 and find it is significantly influenced by the tax burden, the degree of regulation and unit labor costs. Dell’Anno et al. employ the MIMIC technique to estimate the Spanish shadow economy and compare it with those of Greece’s and France’s. They indicate that the Spanish shadow economy follows an upward trend and that after the country’s accession in the EU it moves in the range 24-30 percent of GDP. They report a negative relationship between the shadow economy & GDP, which implies a substitution effect. 17

18. 6. Spain (cont.) Martinez-Vazquez & Torgler study the evolution of tax morale (1981-1990) through the survey data from the World Values Survey & the European Values Survey. They report that the success in designing general institutional reforms (incl. tax policy and tax administration reforms) led to significant increases in tax morale. Corkill indicates that the robust demand for low-cost labour along with the difficulties controlling irregular flows and the repeated regularizations of unauthorized populations make informal employment even more difficult to control. Carrasco et al. find that immigration has a negative effect on the employment rates of native workers. Last but not least are Spain’s corruption issues. 18

19. 6. Spain (cont.) Although according to the Corruption Perceptions Index results for 2013, Spain is placed on the 40th position and thus, reserves a much better placement than the euro-zone Mediterranean countries (namely Greece and Italy), the literature is synthesized by studies that consider corruption (and in particular, political corruption) in Spain a major issue. Moreover, public sector corruption, which has been attributed to the involvement of regional and local administrators and politicians in the country's urban development boom, have angered the public and sparked calls for government reform following the late economic crisis. 19

20. 7. Conclusions The paper reviews the size and determinants of the shadow economy in three countries. With regard to estimations of the size, the findings of studies focusing on a single country differ from the generalized findings of the MIMIC approach (based on macro data). In particular, all primary data estimates of the shadow economy are smaller than the respective estimates generated by macro data. This is not only due to the intrinsic nature of direct survey approaches, which results to lower estimates of the shadow economy, but also because some of the estimates are based exclusively on informal wages and as such, they represent the size of informal labour (which is only a part of the shadow economy). 20

21. 7. Conclusions (cont.) Societal variables impact on tax morale; local autonomy and direct democracy give it a boost (as implied in Switzerland). Demographic variables also have a role that is neglected by the MIMIC approach, while in the case of Spain the role of factor competitiveness is highlighted. With regard to the dimensions of informal labor supply, the main feature of suppliers is skill; Unemployment is often regarded as a driver and students are commonly found in the supply side. Furthermore, the incidence of corruption concerns mainly Italy and Spain, whose economies face the consequences of corrupt political systems that damage the tax morale of taxpayers. 21